January 2015: A Rough Start

The past month has been quite eventful in the financial market and I am sure that some of the decisions (if not all) surprised many of us. After the SNB announce on January 15th, the ECB took over and unveiled a €60bn monthly QE (not open-ended) through September 2016; so 19 months at €60bn equals €1.14tr. The ECB, which has already been buying private assets such as covered bonds (a safe form of debt issued by banks) and ABS, will add an additional €50bn worth of public debt (bonds of national government and European institutions) to its current program starting in March this year. The purchases of these securities (in the secondary market) will be based on the Eurosystem NCB’s shares in the ECB’s capital.
In addition, President Draghi also added that the ECB will remove the 10bp spread on the TLTROs, and the interest rate applied will be equal to the rate on the Eurosystem’s MRO (5bp).

We saw on Friday that EZ preliminary inflation fell by 0.6% in January after a -0.2% print in December, the largest decline since July 2009 when prices also fell 0.6% following GFC.

The ECB decision(s) sent the Euro to newest lows last week, down to 1.1120 (11-year lows) against the greenback and below the 0.75 level (0.7440) against the pound. But more importantly, it sent a bigger amount of government debt in the negative territory (yields). According to JP Morgan, there is currently (approximately) €1.5tr of Euro area government bond with longer than 1-year maturity trading at negative yields over time, and a ‘mind-blowing’ €3.6tr of global government bond debt (nearly a fifth of the total) with negative yields as the chat below shows us. For instance, the entire 10-year Swiss curve is  now negative.

Global NIRP(Source: JPMorgan)

Another interesting topic is of course the 3 consecutive rate cuts (in 10 days) by the Danish Central Bank, that lowered it deposit rate to a record low of -0.5% to defend its peg and keep the Danish kroner (DKK) close to 7.46 per Euro (ERM II since 1999). EURDKK went down below 7.43; we will see this week how much policymakers spent in January in order to counter a DKK appreciation (some reports estimated that the central bank had to sell more than DKK 100bn). As a consequence (of the NIRP policy), a local bank – Nordea Kredit – is now offering a mortgage with a negative interest rate.
I believe the Danish krone is a currency to watch (in addition to the CHF) this month if the situation in Greece deteriorates.

A Weak Swiss Franc…
Since the SNB surprise, the Swiss has remained weak against the major currencies, with USDCHF up 7 figures  (trading currently at 0.93) and EURCHF up from parity to 1.0550. Analysts slashed their forecast for this year and are now predicting a recession (-0.5% according to the KOF Swiss Economic Institute). I like the chart below which shows the 12-month Probability of the top 10 countries to fall into recession in the coming months according to Bloomberg economist surveys.

Probarecession(Source: Bloomberg)

Japan and JPY still under threat over the long-run
In Japan, the 10-year JGB yield rose by 9bp in the last 10 days and is now trading at 29bps. USDJPY tumbled below 117 overnight on Grexit comments and Chinese manufacturing PMI contraction in January (49.8 vs. 50.2 expected), breaking its 117.25 support and extending its trading range to 116 – 118.75. ‘Buyers on dips’ reversed the trend and the pair is now trading at 117.60.
If we look at the long-run perspective in Japan, late macro indicators showed us that Abe’s government will have to do more. Real wages are still declining and fell the most in almost 5 years and the economy has now entered in a triple-dip recession (0.5% contraction QoQ in Q3). On the top of that, inflation has been weakening for the past 8 months as energy prices (mainly weak crude oil) weight on Japanese core inflation rate.
In addition, we saw that Japan plans a record budget deficit for next fiscal year (starting April 1st 2015) to support the economy. FinMin Taro Aso reported that government minister and the ruling coalition parties approved a 96.34tr Yen budget proposal for FY2015/2016. And I believe that we haven’t reached the peak yet, as Japan’s aging population (i.e. increasing social security spending) will ‘force’ the government to print larger and larger deficits. The IMF predicts that the country’s debt-to-GDP ratio will increase to 245% in 2015. It clearly shows that the USDJPY trend is not over yet, and there is further JPY weakness (and USD strength) to come.

On the other side of the Pacific Ocean, the US economy cooled in the fourth quarter. After the 5-percent Q3 print, GDP expanded at a 2.6% annual pace in the fourth quarter (first estimate). Net exports was the largest detractor from Q4 GDP (-1.02%) as imports grew faster than exports. King Dollar continues to benefit from the global weakness with the USD index trading slightly below 95. The equity market still handles the Fed’s withdrawal from the Bond Market with the S&P500 trading around 2,000 (looks like it is out of energy though), while US Treasury yields are compressing to new lows. The 10-year and the 30-year yields are trading at 1.67% and 2.25% respectively (which is quite concerning), and it seems the trend is not over yet. In regards to the inflation rate (that plummeted to 0.8% in December), the Fed delivered a hawkish statement last Wednesday (‘strong jobs gains’, ‘solid pace’ for economy), however dropping the entire ‘considerable time’ sentence and adding ‘inflation is anticipating to decline further in the near term’. The implied rate of the December 2015 Fed Funds futures contract is trading 30bps lower at 41 bps, while the December 2016 implied rate decreased by 60bps to 1.05bps in the past 6 weeks.

An important topic to follow this month will be developments in Greece which are moving very fast since the election on Sunday (January 25) and Syriza’s victory. ECB council Member Erkki Liikanen said over the week end that Greece needs to negotiate a deal before February 28th (when the Greek support program EFSF expires after the 2-month extension approved in December).

Could we survive without QE? (Part II with US yields)

Last month, we wrote an article that summarized all the decision made by the US policymakers since GFC and the impacts as soon as the central bank was stepping out of the market (see article Could we survive without QE?)

We concluded that as soon as the Fed was ‘leaving’ the equity market and let it rely on fundamentals only, we saw sharp correction straight afterwards (See chart below: April—July 2010, July – August 2011, September-November 2012).


(Source: Reuters)

As we are ‘kindly’ approaching the last days of QE with the Fed stepping out of the bond’s market at the end of this month (October 28th), we thought it is a good time to give you an update on the current situation. And Guess what: this time is not different. Since the mid-September high of 2,019.26 (Sep 19th), the S&P 500 is down 7 percent and closed for the second consecutive session below the 200-SMA for the first time since November 2012. And the question we are asking ourself is: how far it could go? We don’t have a specific answer to that, but what we can tell you is that the Fed’s Officials are now realizing their mistake by expressing themselves on their ST monetary policy. Our thoughts have always been that Yellen [& Co.] should have let the market swallow a period without QE before considering raising its ST interest rate. Therefore, we saw at the last minutes (last Wednesday) a different tone, with policymakers suddenly jawboning about the US Dollar Strength (Yes, even the Fed is not comfortable with a strong exchange rate) and the fact that global slowdown could rise risks to US outlook. We expect the tone to remain neutral until the end of the year, therefore capping the appreciation of the US Dollar against all currencies. If the equity market continues to tumble, we think we can even see/hear a couple of dovish statements/conferences as the equity market is one of the most important index (with oil) for US policymakers.

If we have a look at the LT interest rates, the 10-year US yield is now trading at its 18-month low at 2.20%. Clearly, that shows the situation in the market is much more fragile than expected. Moreover, we added a similar chart as the S&P 500 but this time applied to the 10-year yield. We read and heard analysts’ recommendations on yields, and most of them are quiet bearish on Treasuries in the next months to come, targeting a 10-year yield at 3%. However, if we look at the chart below, we can see that each time the Fed stepped back of the bond market, LT yields contracted (March – November 2010, July-September 2011). And it looks like this time is [also] not different with the 10-year yield down 80bps since December’s Taper Announcement.


(Source: Reuters)

Quick update on FX positioning

The US dollar remains strong against all the currencies since yesterday, erasing little by little its post-minutes losses. EURUSD is back to 1.2660, the trend looks bearish and we would set our short term target at 1.2600. A bit late for bears (above 1.2750 was a perfect level to short the pair again), but there is little room for the downside. I’d play short EUR/GBP at 0.7900; a GBP strength relative to the Euro is inevitable, long-term bears just have to be patient for the 0.7500 retracement.

AUDUSD is back to 0.8700 (beginning of the week’s level), despite strong employment reports yesterday in Australia, with full time employment up to 21.6K in September (from 14.3 the previous month). We read that global growth worries will continue to weigh on the Aussie (with always the same story with China’s) slowdown, and the market clearly sees an Aussie trading at 80 cents against the greenback sometime in mid-2015. Next support on the downside stands at 0.8650 (we’ll see if it holds this time).

On the Yen side, we clearly think the bearish USDJPY momentum is not over yet and the JPY should continue to strengthen in the short until we see the big buyers-on-dips. The next support on the downside stands at 107.14, which corresponds to the lower band of the Bollinger Band (20,2x), followed by the psychological 107.

Bonus Chart before US opens:


(Source: Reuters)

Happy October: End of POMO

As October is the Fed’s POMO – Permanent Open Market Operations – last month (as it is mine in Hambros), we will see how the equity market will deal in a period with no QE. The NY Fed released yesterday its purchase operations for the month of October (as you can see it below), stating that the central bank will buy approximately $10bn worth of Treasury securities on an outright basis.

Starting October 28th (the first day of the next FOMC meeting), the equity bulls will start to rely on fundamentals once again. As we say, will this time be different?


(Source: NY Fed)

The market has switched to a risk-off mode for the past couple of weeks with the S&P 500 struggling to trade above the 2,000 level. As you can see it on the chart below, the index (purple line)  is down 2.2% from its September’s high of 2,018.21 (Sep 19th) and AUD/JPY (black bar) is back below the 96.00 level (down 2% as well) and has been fluctuating within a 100-pip range for the past week.


(Source: Reuters)

Earlier this morning, both Germany and UK released a lower than expected manufacturing PMI, coming in at 49.9 (vs 50.3 expected) and 51.6 respectively (vs 52.5 expected). France reported its budget deficit forecasts for the next few years, and the government sees deficit falling to 4.3% of GDP in 2015 (from 4.4% this year), 3.8% in 2016 and eventually somewhere below  the 3% threshold in 2017 (optimistic?).

EUR/USD was little sold this morning after the macro news (1.2584 is today’s low) and is now trading back above the 1.2600 level. Cable hit its 1.6160 support, the 76.4% Fibo retracement of 1.6050 – 1.6526 (as we reported yesterday) before coming back to 1.6200.


(Source: Reuters)

This afternoon, the market will watch West fundamentals with Mortgage Applications, ISM Mfg PMI and ADP National Employment  in the US and Canadian PMI. We don’t see any major developments in the FX market as the market is now focused on tomorrow’s ECB meeting and Friday’s NFP.

Could we survive without QE?

As we are approaching the end of QE (the Fed will probably announce a $10bn / $10bn and then 5bn cut in the next three meetings), we thought it is a good time to have a quick recap of the US QE history since the Great Financial Crisis and its impact on the equity market.

QE1 (December 2008 – March 2010): On November 2008, roughly two-and-a-half months after the Lehman Brothers collapse, the FOMC announced that it will purchase up to $600bn in agency MBS and agency debt and on March 18, 2009, Bernanke and its doves announced that the program would be expanded by a further $750bn in purchases of MBS and agency debt and $300bn in T-bonds. At that time, the Fed had approximately $750bn of Treasuries ad MBS on its balance sheet.

QE2 (November 2010 – June 2011): After 9 months of stagnation in the stock market, the FOMC decided to go for another round of quantitative easing on November 2010 and announced that it will purchase $600 bn of LT Treasuries, at a pace of $75bn per month. Stock market started to rallied once again (S&P was up approximately 10%) as by applying this un-conventional monetary policy, the Fed brought interest down to the floor and ‘forced’ investors to move to the stock market in order to receive a more interesting real rate.

Operation Twist (September 2011 – December 2012): While the stock market was plummeting (S&P was down 300 pts to hit 1,075 a few months after the end of QE2), it didn’t too long for the Fed to react and on September 21st 2011, the FOMC announced Operation Twist. In this program, the Committee intended to purchase, by the end of June 2012, $400bn of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. The main goal was to lower long-term rates in order to stimulate consumer spending and corporate borrowing as growth was judged sluggish by US policymakers at that time. In the middle of 2012, the FOMC downgraded its growth expectations from 3.5% (a year earlier) to 1.9% – 2.4%.

By the end of June 2012, the Fed extended the monetary twist program and said it would purchase another $267bn LT Treasuries by the end of the year, bringing the program up to $667bn.

QE3 (September 2012 – December 2012): With inflation in the US plummeting from 3.9% in September 2011 to 1.4% in July 2012 and credit continuing to contract and still disappointing unemployment figures, the FOMC decided at the September 2012’s meeting (13th) to initiate additional open-ended purchases of residential MBS for an outstanding amount of $40bn every month. Combined with the (approx.) S45bn monthly purchase of US LT Treasuries, the FOMC will increase the central banks’ holdings of LT securities by about $85bn each month, which should ‘put downward pressure on the LT interest rates, support mortgage markets and help to make broader financial conditions more accommodative’ according to the Fed’s statement.

QE4 (December 2012 – December 2013): With Operation Twist coming to an end and US policymakers still judging the recovery as ‘fragile’, the Fed decided to continue to purchase $45bn worth of US LT Treasuries, raising the amount of QE to $85bn on a monthly basis. Its goal at that time was to drive economic activity so that unemployment rate drops to 6.5% (it was standing at 7.7% at that time), as long as inflation remains below 2.5%.

And it went on, that year the Fed increased its balance sheet by a trillion+ dollars, bringing it to a record high of $4trn in December 2013 and which could totally explain the 30% increase in the stock market and the 10% appreciation in the housing sector (Reminder: for the 2013 fiscal year ended Sep. 30th 2013, the US Congressional Budget Office – CBO – announced that the deficit fell drastically to $680bn from $1.087tr in 2012).

QE Taper (December 2013 – ): As the unemployment rate was falling faster than expected in 2013 (down 1% to 6.7% in December 2013), the Fed officials decided to start its QE Taper, announcing that it would scale back its monthly purchases by S10bn each meeting (Auto-pilot strategy). After almost two years of extended QE and with the Fed’s balance sheet up 1.5tr USD (according to FARBAST index), we are now three meetings ahead of the QE exit (last cut expected to be on December’s meeting). The real question now is: would the ZIRP policy on its own be enough to support the equity market (and the housing sector)?

We saw some turbulence back in January this year when the market corrected 5.5 – 6 percent (between mid-Jan and February 3rd) and also in end-July/August where we saw another 4.5-percent correction in the middle of high geopolitical tensions (11.7% of the World is at war according to a DB analysis, see chart at the end). However, it seems that the market has perceived those ‘corrections’ as new buying opportunities and the S&P 500 has been flirting with the 2,000 level for the past week (closed four days out of five above 2,000 over the past week). The index is already up 8.3% since December 31st 2013 close (1,848.36) and we are asking ourself, how far could this go? Especially now that the Fed is now giving us some updates concerning its ST monetary policy, and is potentially considering raising rates (currently at 0 – 0.25%) sometime next year (Q3 seems to be the market’s view). We are going to steal Stanley Drunckenmiller’s sentence: ‘Where does the Fed’s confidence come from?’

Aren’t policymakers supposed to wait a little bit after Taper ends in order to start focusing on its ST interest rate policy?

Even though the rate hike is priced for Q3 next year based on the market’s expectations, we don’t see the point of starting talking about an ‘eventual rate hike’, and especially after the only excuse you had to explain a 2.9% contraction in the first quarter (because there has to be always an explanation) is to blame the weather. In our opinion, US policymakers’ plan sounds a bit ambitious.

Chart: S&P 500 index and QE history


(Source: Reuters)

Another popular chart that we like to look at is the equity market (S&P500 index) overlaid with the Fed’s balance sheet (FARBAST index). As you can see it, it is clear that the Fed’s balance sheet expansion have played in favour of the equity market. Liquidity drives asset price higher and we believe that we are about to hit the high of the asset price inflation we have seen for the past six years…


(Source: Bloomberg)



The JPY and some overnight developments…

The latest development that we found interesting lately was certainly USDJPY breaking out of its [four-month] 101 – 103 range on August 20. Despite US LT yields trending lower (10-year trading below 2.40%) and the BoJ showing no interest of increasing QE even though the economy printed dismal figures (except a strong CPI), the Yen has weakened by almost two figures in the past couple of weeks against the greenback and is now trading slightly below 105.

We were a bit surprised by this breakout as we thought until lately that the JPY had no reason to depreciate against the US Dollar (especially with a quiet BoJ and US LT yields expected to remain low in H2 according to analysts). Our thoughts was that the Yen depreciation mainly came from the carry trade positions (‘risk-on’ sentiment) with AUDJPY trading at new highs at around 97.50 (which corresponds to June 2013 levels), and we first assumed that the risk-on situation isn’t fully established and the market was just looking for ST opportunities and that any major ‘bad’ news could potentially trigger some massive carry unwinds as we saw previously (aka Yen appreciation).

However, after a few chats with some FX strategists (who we all thank for their kind answers), a first important thing to notice is the decrease in the 6-month (daily) rolling correlation between AUDJPY and S&P500 from 67% back in mid-February this year down to 47% today. In other words, the Japanese Yen sensitivity to risk-off moves has fallen as you can see it below in the Bloomberg Spread Analysis.Audcorr

(Source: Bloomberg)

Secondly, traders and investors are becoming more confident on a BoJ move later on this year, and further easing by JP policymakers (after Japan dismal figures: July household spending collapsed 5.9% YoY, Q2 GDP shrank by annualized 6.8% erasing Q1 gains, Housing starts down 14.1% in July…) is the main driver on Yen weakness according to analysts.

Eventually, another factor to look at would be Japanese institutional investors switching from bonds to stocks (and international stocks and bonds); we saw strong demand for French OAT from Japan last week. For instance, as you can see it below, GPIF, Japanese 1.2-trillion-dollar retirement fund, reduced its domestic bonds holdings by almost 10 percent in the past 3 years and has gradually increased its holdings of Japanese equities and International Bonds and Stocks. In June this year, it reported that it held 53.36% of domestic bonds and 17.26% of domestic stocks, down from 62.64% and 12.37% respectively back in 2011 (Abe’s effect). As a reminder, GPIF has a 60% target for domestic bonds and 12% for Japanese stocks, with 8% and 6% deviation limits respectively for those assets.


Having said that, the 105 level could potentially act as a psychological resistance at the moment, next important level on the topside stands at 105.44, which corresponds to January 2nd high. USDJPY looks a bit overbought as you can see it on the chart below, and we will look for lower levels to start considering buying some more.


(Source: Reuters)

Aussie pausing as expected…

The late US Dollar rally (USD index flirting with 83.00, its highest level since July 2013) hasn’t impact the Aussie (that much) and AUDUSD is still trading within its 5-month 0.92 – 0.95 range. The RBA left its cash rate steady at 2.50% (as expected) and looks unlikely to change it for some time, which is what we were assuming (see our article RBA is giving up…). The BBSW rates, which correspond to transparent rates for the pricing and revaluation of privately negotiated bilateral Australian dollar interest swap transactions, are trading quite flat with the 1-month and 6-month bills paying 2.66% and 2.69% respectively.

Despite AU annual inflation approaching the high of the RBA [2-3] percent inflation target range (Trimmed mean CPI came in at 2.9% YoY in the second quarter), AU policymakers noted slack in the job market and rising house prices.

The trend on AUDUSD looks bearish at the moment; we will try to sell some if the pair pops back above 0.9300 ahead of US employment reports on Friday. I’d put an entry level at 0.9330, with a tight stop loss at 0.9360 and a target at 0.9210.

Figures to watch this week:

AU GDP YoY (sep. 3rd): expected to ease back to 3.0% in the second quarter, down from 3.5%.
AU Trade balance (Sep 4th): expected to come in a -1.51bn AUD in July.
US Non-Farm Payrolls (Sep 5th):  expected to print at 225K in August, above the 200K level for the for the seventh consecutive month.